Since the 19th century, economists have been speculating about the
existence of a " Giffen good"--a good with an upward-sloping
demand curve, meaning that demand for the good increases as its price
increases (all else equal). At first blush, such a good seems
impossible.

A normal demand curve slopes downward for two reasons: First and
most obvious, as the price of the good increases, consumers will
substitute other products in its place--what is known as the
"substitution effect." That is, if the price of a hamburger
goes up, consumers will shift to eating more pizza and chicken
sandwiches.

A second reason is that if the price of a commonly purchased good
increases, consumers are left with less real income. Thus, consumers
simply won't be able to buy the same amount of goods and
services-including the costlier good--that they did before. This latter
phenomenon is called the "income effect," because
consumers' purchasing behavior changes depending on their real
income.

Yet, some goods clearly do have a negative income elasticity,
meaning that when a person's income increases, he buys less of the
good. In essence, in these cases the income effect works against the
substitution effect: suddenly wealthier consumers purchase less Ramen
noodles and fast food even though they can now afford to buy more of
those goods. Instead, those consumers buy more steak and more meals at
upscale restaurants. Because of this characteristic, economists refer to
goods like Ramen and fast food as "inferior goods," and steak
and upscale restaurants as "superior goods." Notice that if a
person's real income were to fall, Ramen and fast food consumption
should increase.

Given the existence of inferior goods, it's possible to
imagine a Giffen good. A good could be so inferior that, if the
consumer's income were to fall at a time when the inferior
good's price is rising, the income effect on the inferior good
could fully overcome its substitution effect. Voila: consumption of the
inferior good increases despite its rising price, and the good is a
Giffen good.

Despite the theory, it's difficult to identify a real-world
case of a Giffen good. The most plausible candidate in history seems to
be potatoes in Ireland during the 1845-1849 Great Famine, when
consumption seemed to not lose pace despite soaring prices. But even in
that extreme case, scholars are uncertain if potatoes actually passed
the positive-slope threshold of a Giffen good.

However, some new evidence suggests that cigarettes may approach
this dubious distinction for an important group of society: low-income
pregnant women. It's a possibility that suggests the government
should hesitate before it considers future "sin" taxes.

Substituting away from health / The data come from a new paper on
cigarette taxes published in the journal Pediatrics. The paper's
top-line finding is the estimate that a recent $1 per pack federal
cigarette tax increase reduced smoking in expectant mothers, which in
turn reduced infant mortality by 1 per 1,000 live births. Despite that
effect, the authors did not recommend further tax increases, worrying
that some expectant mothers may simply be unable to stop smoking. If
their taxes were increased further, these women may be forced to reduce
their consumption of healthy goods and services to be able to afford
(and perhaps even augment) their smoking habit. As a result, further
reductions in infant mortality from higher taxes may not be
forthcoming--in fact, some of the gains from the last tax increase could
potentially be undone.

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The authors' show of discretion when it comes to their
study's implications is rare and welcome. I attribute their wisdom
to their being doctors and not policymakers, and thus they are familiar
with unwelcome side effects. When it comes to tax policy as well as
regulatory policy, the notion of diminishing returns often gets ignored
by government.

For instance, a decade ago, government considered lowering the
maximum allowable concentration of arsenic in drinking water from 50
parts per billion to 30. (See "Special Report: The Arsenic
Controversy," Fall 2001.) Evidence that the proposed standard would
have yielded significant health benefits was thin and cost estimates for
compliance with the proposed standard were enormous. That led to the
worry that the proposed standard would, on net, harm public health
because money devoted to arsenic reduction would be reallocated from
other uses--including other initiatives to improve public health and
safety.

Likewise, higher cigarette taxes can come with a whole host of
unwelcome outcomes. Besides a potentially deleterious effect on pregnant
smokers and their children, we might also expect a greater demand for
black-market untaxed cigarettes--something that inevitably occurs with
each cigarette tax increase--or smokers substituting toward other
substances that can be just as harmful to one's health as
cigarettes, if not more so. For instance, while I welcome the slowly
spreading legalization of marijuana, there's no real health
difference between smoking a tobacco cigarette and a marijuana
cigarette. The tax on both should be, apropos Pigou, high enough to
correct any external costs of consumption that are borne by society, but
no higher.

Giving up cigarettes is easier said than done, of course. Nicotine
is an addictive substance and its effects on the nervous system differ
greatly from person to person. Some people find kicking the habit to be
extremely difficult, no matter how strong their resolve to avoid tobacco
use, while others find it easier to quit. What's more, some
low-income people may not have knowledge or ready access to tobacco
substitutes or may not appreciate the potential costs of continuing to
smoke during a pregnancy.

In other words, the decision to smoke during a pregnancy can be
complicated, and a prohibitive tax alone is not going to eliminate it.
In a similar vein, a recent National Bureau of Economic Research paper
found a virtual nonresponse to higher cigarette taxes in smoking among
teenagers following the most recent tax increases at the state level.
(See "In Review: Working Papers," Winter 2015-2016.)

Policymakers tend to reflexively treat a tax on goods with high
social costs as an easy and uncontroversial method to improve societal
outcomes, but the world is more complicated than that. At some point the
gains from additional cigarette tax increases diminish and the tax
becomes little more than a way for government to extract money from the
low-income Americans who now constitute the majority of smokers in the
United States. Cigarette taxes may be approaching that stage.